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The Single Most Important Factor in Investing

Aug 17, 2007
When you were a child, your parents may have encouraged you to save some of your allowance in order to be able to purchase something that you wanted. They might have later on helped you to learn more about the value of money by expecting you to get a job to help pay for your first car or your college education. Hopefully they also taught you about the value of your credit and how important it is to protect it. While these are wonderful lessons to learn, they neglected what in the long run can prove to be the most important factor in investing the time that your money is invested.

There is a time value of money. The $100 that you have in your savings account won't have the same buying power in a year that it does today. This is because inflation causes the value of money to depreciate. So, for argument's sake, let's say that the inflation rate for the next year is 2%. Then you would find that your $100, if it earned no interest or return over the year, would have lost 2% of its value in the year's time. So this time next year, your $100 will have the buying power of what $98.00 can buy you today. This is a simplistic example, but it illustrates the fact that your money should be invested on the one hand in order to fight against the depreciation that time will cause to happen unless you are countering it with some sort of interest or return on your money.

On the other hand, you will see that the longer that you invest your money, the more rapidly your earnings will increase. This is because of compounding interest. Let's take the example of $100 again from above. If you were to invest that $100 in a fund that earns a 6% return on average, then in one year you would have $106 in that account. Assuming that you leave the original money and the first year's earnings in the account, and that the interest rate remains at 6%, then in the next year you will earn that 6% on the $106, bringing your balance to $112.36. As you can imagine, the longer you leave the money and all earnings in the account, the more you will earn.

Here's a simple rule to help you determine how long it will take for your money to double, regardless of how much you start with or the interest rate that it is invested at. It is called the rule of 72. To use it, take the number 72 and divide it by your interest rate. That will tell you how many years it will take for your money to double itself. Using our $100 example again, take 72 and divide it by 6, the interest rate we used above. The result is 12, meaning that at 6%, it would take 12 years for the $100 to become $200. Now, this doesn't seem very powerful, but imagine if you were starting with a larger amount, and that you continually added to it. The sooner you start, the more you will earn from compounded interest as well in fact, if you are able to leave your money in for 40 years, the money will likely more than double between years 30 and 40 alone.
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